Palladium: This White Metal That Needs to Be on Your Radar (PALL, PPLT. PGM)

If you’ve been long palladium, you know much of the ride over the last two years has been remarkable. The white metal gained 350 percent in value between January 2009 and February 2011. It practically doubled in price in 2010 alone – the best performance of any commodity (followed by silver, corn and wheat). Palladium investors were flying high…

During the last two years, the automotive industry experienced a slow, steady rebound from its financial crisis collapse. The sector accounts for 53 percent of all palladium demand. Throw on top of that a tight supply situation and new exchange-traded funds (ETFs) gobbling up ounces, and we had bullish conditions driving the metal’s run… and the real makings of a supply deficit.

Annual production of palladium is a mere six million ounces. So when single ETF holdings started tipping over two million ounces, and more physical-backed palladium ETFs were being introduced, it was a juicy-looking crunch.

But we hit a bump in the road…

Things started to sour in February with unrest and revolution in northern Africa and the Middle East. Then tragedy struck Japan – the world’s largest automaker. The market came tumbling down. Not surprisingly, since February 11, palladium prices have been volatile to say the least.

This year, it fell from $859 to $684 per ounce in the aftermath of the earthquake. Palladium then recovered briefly – moving back up to $800 – before stumbling again to $732.

So far this year, palladium is the worst-performing metal. And among commodities, there are few performing worse, such as lumber and sugar’s 20 percent-plus declines.

It’s been a tough couple of months. Particularly with silver blowing through the $40-per-ounce veil and gold hitting new records over $1,500. All that makes palladium’s sluggish performance look all the more tarnished and worrisome.

So what to do?

Palladium’s Principal Market

Palladium’s principle market isn’t jewelry, but industrial uses. It’s found in cellphones, iPods, LCD TVs, computer monitors and, as previously mentioned, autocatalytic converters in cars.

With automotive and electronic uses accounting for 68 percent of total palladium demand, the devastation in Japan was a double whammy for the white metal. But the good news is that we seem to have hit the bottom.

Once palladium dipped below $700, Chinese buyers rushed in, seizing the buying opportunity. In 2010, China used 930,000 ounces of palladium, but that’s expected to increase rapidly. Car sales in China are expected to increase another 10 to 15 percent this year, after a 32 percent pop in 2010.

So despite the volatility, the price of palladium weathered the Japan earthquake quite well.

Japan accounts for 14 percent of global vehicle assembly capacity. With Toyota Motor Corp. (NYSE:TM) unable to return to normal production output until the fourth quarter, investors have their concerns. For example, it’s estimated that Toyota lost 325,000 light vehicles that would’ve been built in the end of March. Each of those vehicles would have required between four and five grams of palladium for their catalytic converters.

The price dip was well within reason. And palladium was a little overheated, due for some sort of correction.

Brighter Days Ahead for Palladium

But Toyota is just one piece – though a large piece – of the global auto resurgence.

  • Global light vehicle sales are expected to increase around 50 percent per year over the next five years. China will be the main driver here – not Japan – with its palladium demand projected to increase 36 percent.
  • In the United States, the 2011 outlook is for about 13.25 million vehicles. By 2015, depending on whether you believe auto executives or industry analysts, U.S. vehicle sales are expected to hit between 14.5 million and 16 million units.
  • Plus consumer electronics and dental palladium demand will continue to be bullish in 2011 after experiencing an 11 percent jump in 2010.

So palladium demand will still be strong, while supply is a slightly murkier situation.

Russia supplies 50 percent of the world’s palladium. It’s also been keeping the palladium market’s head above water by supplying an average of one million ounces to the open market each year from state stockpiles since 2005. But the world’s largest palladium producer, Norilsk Nickel (PINK:NILSY) announced that Russia’s stockpiles were being quickly depleted. And that 2010 would be the last year any significant amount of the white metal would hit the open market.

By 2012, Russian palladium stockpiles will likely be exhausted. Meaning that demand must be met from mining, likely through projects in South Africa and Zimbabwe.

Even Norilsk, which supplies 38 percent of the world’s palladium, has seen production steadily decline by 13 percent since 2005.

A Palladium Supply Deficit is Imminent

We already saw in 2010 that Russia’s palladium shipments to Switzerland, one of Europe’s main precious metals trading hubs, fell 12 percent to a mere 500,000 ounces. The 20-year average on these shipments is 1.3 million ounces.

Because of all this, there’s expected to be a palladium supply deficit for much of the next decade. This is why BNP Paribas projects the white metal’s price to hit $1,000 per ounce next year – despite the destruction in Japan and its long, slow road to recovery.

The spot market for palladium is again trailing back down to start the week because of Toyota’s production outlook. But the precious metal will regain strength in the latter half of 2011 and keep moving higher from there. Look for palladium miners, especially in South Africa – the world’s second-largest palladium producer – and physical-backed ETFs to benefit.

Good investing,

by Matthew Carr, Investment U Research Analyst

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